Editor’s Note: This article provides a broad overview of the use of state law assignments for the benefit of creditors (ABCs) as an efficient alternative to chapter 11 and chapter 7 liquidations conducted under federal law.For a great discussion on other options available to struggling businesses, we recommend this webinar.

Financially distressed businesses faced with unlikely prospects for reorganization—and the creditors who can influence their decisions—often take advantage of the chapter 11 liquidation option, where the debtor’s assets can be sold free and clear of all liens, claims, and encumbrances, leaving the net value created available for distribution to creditors.

In chapter 7 liquidations, a trustee is appointed to liquidate assets. In chapter 11 liquidations, in contrast, management typically continues operating the business throughout the bankruptcy process.

A state-law alternative[i] to a federal bankruptcy liquidation (whether through chapter 11 or chapter 7), known as an assignment for the benefit of creditors (ABC), can facilitate a business liquidation without many of the time-consuming delays, complications, or added costs associated with the federal bankruptcy process.

An assignment for the benefit of creditors (ABC) is not an appropriate vehicle for a company looking to reorganize. By contrast to a bankruptcy case, no automatic stay is imposed to limit creditor action upon the commencement of an ABC. An ABC also will not discharge any debt or liability that is not repaid in full. What the ABC can do for the debtor and insiders, if properly managed by the assignee, is diminish creditors’ concerns that the board or management is standing in the way of recovering value for creditors, while the assignee sets about doing just that.

A simple and accurate way to think of an ABC is as a trust agreement whereby the owner of a distressed company irrevocably transfers title, custody, and control of its assets to an impartial third party, the assignee, who is entrusted with the assets and has duties to liquidate the assets in an efficient, orderly manner and distribute net proceeds to creditors.

To authorize an ABC properly, the debtor must abide by the requirements of its articles of incorporation and bylaws, as well as those of its state of incorporation, which typically require a resolution of the board of directors and shareholder consent. The choice of the assignee is not legally subject to approval by creditors. ABCs generally commence at the time of the assignee’s acceptance of the debtor’s assignment of its assets, which must be evidenced by a written document.

The assignee is required to give notice of the assignment to all of the debtor-assignee’s creditors, equity holders, and other parties of interest, including taxing authorities. The ABC trust is legally distinct from the pre-assignment debtor. Therefore, judgments or garnishments obtained or liens filed against the debtor-assignor after the assignment has occurred generally do not attach to the assets held in trust by the assignee.

To maximize the value of assets distributed to creditors, the assignee may operate the business for a period of time prior to selling the assets. Operating the business makes sense if the expected resultant increase in recovery outweighs the additional costs of operating the business and is subject to the availability of sufficient liquidity. An “operating” ABC can make sense where, for example, there is:

A need to complete work in process or confirmed customer orders

An ability to hold going-out-of-business sales, as is often the case with retailers

A going-concern buyer on the scene

When operations have ceased before the assignment is made or are stopped by the assignee, assets can be liquidated through various means, including an auction or a negotiated sale. Regardless, potential buyers will typically buy only if they can do so “free and clear” of liens on the assets being bought. For this reason, an ABC is often done in compliance with personal property foreclosure procedures set forth in Article 9 of the Uniform Commercial Code.

Before accepting the assignment, the prospective assignee will review certain aspects of the debtor, including:

The accuracy and completeness of debtor’s information to be used to document the inventory of assets and liabilities, and analysis of viability, liquidity, and prospects for recovery of value under various scenarios.

Potential environmental risks, if real estate assets are involved.

A determination of whether the assignee will need specific approvals or licenses to operate the business or liquidate its assets.

The existence of liens and the status of their perfection. If one or more properly perfected liens on the substantial assets of the debtor are found, the prospective assignee will likely agree to become the assignee only with approval of the secured creditors of the company.

Documenting the inventory of assets and liabilities early in the case is an important milestone in the administration of every assignment. At the time the assignment is made, the debtor-assignor must turn over to the assignee all of its books and records, including a complete list of its assets and liabilities as of the date of the assignment, as well as a list of all creditors, their addresses, and the indebtedness owed to each.

The assignee typically is required to provide an accounting of the debtor-assignor’s assets. Such accounting will be submitted to a court or to creditors, depending upon what the law of the state requires. (It also can reassure creditors, as one might imagine.) As part of this process, the assignee may identify each asset class, as well as its known or estimated value. In addition, the assignee should seek to establish a bar date for filing claims with the assignee—to help the assignee administer the distribution of any net proceeds generated from liquidation or sale of the debtor’s assets and provide notice of the bar date to all creditors, equity holders, and other parties of interest, including taxing authorities

[i] All viable alternatives to maximize value are worthy of consideration when financially distressed companies are on the verge of insolvency. Options other than assignments for the benefit of creditors lie outside of the purview of this article, but are discussed at length in Strategic Alternatives for Distressed Businesses (West, 2012).

Steve San Filippo is the founder and principal of San Filippo & Associates. He has over 30 years of management experience providing restructuring, rebuilding, remaking, and transformational leadership to privately owned companies. Steve has assisted clients globally across a wide range of industries. During the past five years, he has served as chairman and chief…